A better outcome for whom? Unpacking the safe harbour reforms
|Services:||Corporate & Commercial, Restructuring & Insolvency|
|Industry Focus:||Financial Services|
|Date:||26 October 2017|
|Author:||Ben Shaw, Partner|
What you need to know
- Australia’s safe harbour legislation is not explicit as to the meaning of, or the considerations that will inform, a “better outcome for the company” which is the concept underpinning the protection afforded to directors under the new regime.
- Rather than attempting to balance often misaligned interests of shareholders and different classes of creditors, directors ought to focus on the 'enterprise value' of the company.
- Such an approach is consistent with directors’ duties in the zone of insolvency and aligns with the rationale of the safe harbour reforms, being the avoidance of value destruction.
A “better outcome for the company”
A central theme in Australia’s safe harbour legislation is a “better outcome for the company”. Achieving a “better outcome” is the ultimate aim of the course of action to be taken by directors to enliven the protection afforded by the safe harbour regime. Conversely, directors will be outside safe harbour once that course of action ceases to be reasonably likely to achieve that “better outcome”.
Working towards a better outcome for the company sounds simple, at least conceptually. But is it? The legislation itself is somewhat circular, defining “better outcome” to mean an outcome that is better for the company than the immediate appointment of an administrator or liquidator. But who, or what, is “the company” in this context?
Is it both shareholders and creditors, or only creditors?
Is it creditors as a whole, or are the interests of secured and unsecured creditors (present or future) treated differently?
What about the interests of secured creditors 'in the money' and those that are out of it?
The interests of all of these groups may not be aligned when weighing up a formal appointment versus an informal work out. Even different groups of unsecured creditors may have competing interests – for example, continuing trade creditors or priority creditors (such as employees) are often more interested in the company continuing than, say, unsecured financiers or 'one-off' creditors.
Where company directors and their advisors need to determine whether a particular course of action will constitute a better outcome for the company, such that the directors may enjoy the benefit of safe harbour protection, they may understandably experience some uncertainty about how that assessment can best be made.
One approach would involve an attempt to balance or apportion the respective interests of a company’s various stakeholders.
A second approach is to focus instead on the company as an entity separate from its members and creditors or, in other words, the 'corporate enterprise'. Adopting this approach to the better outcome enquiry is advantageous because it is:
- simpler for directors and their advisors (which is important at a time when decisions need to be made rapidly)
- consistent with the applicable directors’ duties
- aligned with the objective of safe harbour, being the avoidance of the value destruction which can occur as a consequence of a formal appointment.
A balancing act
In ordinary circumstances a company’s directors owe duties only to the company’s members as a corporate body. In the 'twilight zone' of insolvency, directors must take into account the interests of shareholders and creditors. The duty to creditors is an aspect of the directors’ duty to the company, rather than a separate, independent duty.
What this means is that an assessment about the “better outcome for the company” in a safe harbour context cannot disregard the interests of shareholders and creditors, as any action taken must be consistent with directors’ statutory and fiduciary duties.
As touched upon above, shareholders’ and creditors’ interests can (and, in the twilight zone, will often) be divergent. The same can be said about the interests of various classes and sub-classes of creditors. The courts offer little guidance as to precisely how stakeholders’ interests are to be taken into account in directors’ decision making in the twilight zone. Some attention has been given to the intersection between shareholders’ and creditors’ interests, to the effect that giving creditors’ interests paramountcy is going too far. There has also been some consideration of the potentially different treatment of existing and new creditors. Beyond that, however, the authorities and commentary suggest some kind of nebulous balancing exercise may be required. This is not a satisfactory position for directors to be in when they are required to make rapid decisions in the zone of insolvency. It is also unlikely to fulfil the purpose of safe harbour, being to drive the kind of culture change which encourages reasonable risk taking amongst directors.
An enterprise value approach
Conceptualising directors’ duties as being owed to the corporate enterprise as a separate entity rather than to shareholders and creditors (including in the zone of insolvency) is not new. In Australia, it was the subject of extrajudicial writing and commentary as far back as the 1970s. More recent observations of the Supreme Court of Canada indicate that the object of directors’ duties framed as owing to the corporate enterprise is the maximisation of the value of the corporation.
Adopting that notion of directors’ duties achieves alignment with the objectives of the safe harbour legislation, and is arguably well adapted to informing whether a course of action is likely to result in a “better outcome for the company”.
A director in the zone of insolvency determining a course of action with a view to achieving a better outcome for the company may therefore simply ask themselves (or their advisors):
Is the debt incurred in connection with a course of action reasonably likely to maximise the value of the enterprise?
While the answer may be complex, asking this question is considerably simpler than evaluating the merits of the proposed action through the prisms of the company’s shareholders and creditors (including the various subclasses of creditors). It is also an approach that is consistent with the concurrent directors’ duties owed to the company, and that accords with the plain meaning of the words used in the safe harbour provisions.
|Click here to read the other articles in this series, or to contact a member of our team.|
Company directors and their advisors will no doubt be eager to see formal guidance emerging from the courts as the “better outcome” concept is considered and tested in the context of real safe harbour situations.
But insolvent trading cases are rare, and now the safe harbour defence will make them rarer still. Consequently, it is not expected that judicial guidance as to the proper approach to a “better outcome for the company” will be received in the near future.
For more information, please contact:
1. Walker v Wimborne (1976) 137 CLR 1.
2. R v Spies (2000) 201 CLR 603.
3.Westpac Banking Corporation v The Bell Group Ltd (in liq) [No 3]  WASCA 157.
4. See Nicholson v Permakraft (NZ) Ltd  1 NZLR 242 per Cooke J at 250.
5. This view was propounded by Dr BH McPherson in Duties of directors and the powers of shareholders (1977) 51 Australian Law Journal 460 and Dyson Heydon QC in 'Directors’ Duties and the Company’s Interests' P D Finn (ed) Equity and Commercial Relationships (Law Book Co, Sydney, 1987).
6. Peoples Department Stores Inc. (Trustee of) v Wise  S.C.R. 461.